This week we closed our last March position just in time to avoid a nearly 2.5% jump in the S&P 500 (through Friday), a 6.5% drop in the VIX, and the complications of SPY ex-dividend. As mentioned in previous Updates, there occasionally are conditions under which it makes sense to keep some positions open through some or all of expiration week; but those conditions slipped away last week, and we’re all the better for having followed the Calendar Options strategy rules. I haven’t backtested our hedging strategies through this week, but if we had simply held our two open trades from last week through Friday morning, we’d be looking at a 10% Model Portfolio loss.
In contrast, we chose to limit risk in the face of anticipated underlying price volatility and falling implied volatility right from the beginning, by opening just one core, double-calendar, position. Despite the adverse conditions, we were able to close that position with just a small loss (1.06%). We didn’t fare quite so well with the hedge trade entered on March 6th, but by strictly adhering to our risk-management rules, we were able to limit our Model Portfolio loss for the month to just 3.27%, after accounting for a 12.62% loss on the (relatively small) hedge position.
The S&P 500 Index had another outstanding month, with a gain of 3.15%; VTY was less impressive, with a return of 0.40%. Here’s the latest chart of Calendar Options Model Portfolio returns since inception, compared to the S&P 500 and VTY:
Conventional wisdom would have you believe the reason our calendar-spread strategy underperformed this month was that non-directional strategies don’t work in trending markets. While a strong trend certainly doesn’t help, we’ve proven that myth false too many times to count. Another misconception, though one with more truth than the prior, is that a calendar strategy can’t make money when implied volatility is falling. “Vol crush” is, indeed, a significant risk, but our risk-management rules and the vega-hedging component of our strategy have done a pretty good job of protecting us from being done in by a big drop in IV.
Yet another risk I’ve taken great care to address in the strategy rules is that of whipsaw reversals. We’ve seen a a lot of improvement in this area with each new version of the strategy, but whipsaws remain our biggest challenge, next to major outlier events such as epic crashes. There’s only so much one can do to make a single strategy work in both sideways and trending markets, limit tail risk, and not suffer a loss in a whipsaw reversal. And this month we were dealt one heck of a bear trap:
There’s no value in making excuses, but it’s important to evaluate every losing month and consider whether the loss is within a reasonable limit, in the context of overall strategy performance and the severity of the conditions that led to the loss. Out of the 12 monthly losses taken since inception, this period’s drawdown was less than seven of them, and well below the average loss. Our average return in winning months is 5.35%, and the proportion of positive months since inception is about 2/3.
Bottom line: If you average a 5.35% return in two out of three months, a 3¼ percent loss—after being hit with an extreme example of one of your biggest risks—is…pretty damn good. We’re never happy with a losing month, but the test of a winning strategy is outperforming over the long-run and booking relatively small losses in challenging periods. By those measures, we remain firmly on track, maintaining an average annualized return since inception of 15.8% (not including commission costs).
A word for recent subscribers: We focus on long-term out-performance, and the biggest mistake retail (and, yes, professional) investors make, regardless of their investment style, is to abandon strategies with good long-term performance after a losing (or underperforming) month (or quarter, or even year, if the strategy is fundamentally strong). At Condor Options, we value our subscribers more than profits—so if you find better education, with better long-term results, at a better price, go for it. Just don’t go down the all-too-common road of retail-investor losses by jumping from one newsletter to another chasing short-term performance.